In recent decades, European countries enjoyed a "peace dividend" that allowed them to reduce military spending and redirect resources towards social welfare programs and investments.

However, a shift in the geopolitical landscape, marked by U.S. President Donald Trump's threats to reduce support for Europe, is prompting a reevaluation of this trend.

Currently, the European Union allocates just under 2% of its GDP to defense.

European leaders are discussing increasing this expenditure to as much as 3.5% of GDP, or even more over the next decade, a level not seen since the late 1960s.

Such an increase would require an additional allocation of approximately $387 billion per year for the EU member states — roughly equivalent to the annual spending on housing and services across the continent.

Mark Zandi, Chief Economist at Moody's Analytics, noted that Europe had benefited from a peace dividend in recent decades, which freed up economic resources for private investments and allowed governments to bolster social services and financial safety nets.

However, this reality is coming to an end, leaving Europe with limited options going forward.

Historically, Europe’s low defense spending has been buoyed by protections received from the United States, which in turn enabled the establishment of one of the most generous social safety nets in the world for its aging population.

Across the EU, social protection as a share of government expenditure rose from 36.6% in 1995 to 41.4% just before the COVID-19 pandemic, according to Eurostat data.

For example, Germany's social protection spending, which includes welfare and pension expenditures but excludes health care, is more than double that of the United States as a percentage of GDP. Such disparities are even more pronounced in France.

To increase defense spending — which had been halved relative to GDP from 1963 to 2023 in most European economies — countries will face the challenge of cutting existing expenditures or taking on higher levels of debt, a prospect that many European nations may find difficult to finance.

Attempts to reduce spending on social safety nets have proven tedious and politically challenging.

For instance, France's efforts to cut pension expenditures sparked widespread public protests in 2023 when President Emmanuel Macron proposed raising the retirement age by two years to save approximately €18 billion annually.

Current discussions about potentially reversing this plan are occurring under pressure from labor unions and opposition parties, despite concurrent negotiations among ministers regarding increased defense budgets that would overshadow pension savings.

In response to Trump's rapprochement with Russian President Vladimir Putin and U.S. threats to withdraw from NATO, European nations are now compelled to pursue a more independent defense policy.

Economic analysts, like Klaus Vistesen from Pantheon Macroeconomics, have expressed concerns that the capabilities gap between nations remains significant and termed the progress as too slow, indicating Europe is entering a prolonged and chaotic transition.

The number of personnel in the British Army, for instance, has plummeted by more than half from 1985 to 2020, down to 153,000.

Overall troop numbers in the EU have contracted from 3 million to 1.9 million.

In recent years, defense expenditure has begun to rise again.

The EU's defense spending was estimated at €326 billion in 2024, representing approximately 1.9% of GDP, up from €214 billion in 2021. This figure surpasses the average of about €150 billion spent annually over the 15 years leading up to 2019, according to the European Council.

However, the required budget increases remain substantial, ranging from €160 billion annually over the next five years according to Goldman Sachs, to an estimated annual range of €230-460 billion according to Pantheon Macroeconomics.

While larger loans could fund the initial adjustments for fiscally capable countries, it will ultimately be taxpayers and those benefiting from social safety nets who bear the burden of rearmament.

Guntram Wolff, a senior research fellow at Bruegel, remarked that in terms of GDP contributions, in this "new world," Europe is nearing defense spending levels reminiscent of the 1980s, necessitating greater sacrifices in public budgeting.

Foreign aid programs are expected to be among the first casualties of these adjustments, as evidenced by the UK government's announcement of significant cuts.

Difficult decisions are anticipated regarding the future of welfare budgets.

Vistesen indicated that "war taxes" might become necessary.

Recently elected German Chancellor Friedrich Merz unveiled plans to lift public debt limits specifically for defense funding.

European Commission President Ursula von der Leyen proposed an exclusion from EU fiscal rules for additional loans totaling €800 billion.

The U.K. government committed to defense spending of 2.5% of GDP by 2027, which will be funded through cuts to foreign aid, with a subsequent gradual increase to 3%.

Poland has also dramatically increased its military expenditure, aligning with Trump's demand that NATO nations raise spending to 5% of GDP, setting a target of 4.7% in 2024, the highest among alliance members led by the U.S.

While Germany may have the capacity to increase its debt burden, many other European nations face more challenging circumstances.

For instance, Italy’s debt-to-GDP ratio has escalated from 31% in the 1960s to 137% by 2024, according to European Commission data.

Similarly, both France and the U.K. face debts surpassing their economic output, compounded by high fiscal deficits.

Currently, the EU allocates 2% of GDP to interest payments, with Italy's figure being double that amount.

Reducing government spending on pensions and healthcare poses a particularly daunting challenge, given that the continent has the oldest population in the world, which is expected to translate into rising social expenditures alongside declining revenues as the working-age population contracts.

According to Jack Allen-Reynolds, an economist at Capital Economics, "governments will need to borrow more, which will upset bond investors, or implement budget cuts, which will anger voters."